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Federalism: Federalism is a system of government in which power is divided between a central government and regional governments. This division of power is often enshrined in a constitution, which outlines the responsibilities of each level of government. See also State.
Annotation: The above characterizations of concepts are neither definitions nor exhausting presentations of problems related to them. Instead, they are intended to give a short introduction to the contributions below. – Lexicon of Arguments.

Author Concept Summary/Quotes Sources

Constitutional Economics on Federalism - Dictionary of Arguments

Parisi I 210
Federalism/Constitutional Economics/Voigt: (…) the conjectured economic benefits of federalism are expected to arise from the competition between constituent governments; its costs are based on the necessity of cooperating on some issues.
Hayek: Thus, Hayek (1939)(1) argues that competition between governments will reveal information on efficient ways to provide public goods. Assuming that governments have incentives to make use of that information, government efficiency should be higher in federations, ceteris paribus.
Tiebout: In Tiebout's ( 1956)(2) famous model, the lower government levels compete
Parisi I 211
for taxpaying citizens, thus giving lower-level governments an incentive to cater to these citizens' preferences.
Costs: (…) if the number of states is large, economies of scale in the provision of public goods could remain unrealized. For example, Tanzi (2000)(3) suspects that those providing public goods will be insufficiently specialized.
Moral hazard: Also, federal states need to deal with a moral hazard problem that is not an issue in unitary states.* The federal government will regularly issue "no-bail-out clauses" but they will not always be credible.**
With regard to the issue of overborrowing, Wildasin (1997)(6) argues that large states can become "too big to fail." On the other hand, it has been argued (Rodden and Wibbels, 2002)(7) that large member states can internalize more of the benefits generated by responsible fiscal policies.
Solution: A number of factors might mitigate this free-rider problem: If strong, disciplined parties are active throughout most of the federation and one party is in charge of the federal as well as most of the constituent governments, then party leaders may be able to prevent state officials from externalizing the negative effects of overborrowing (Rodden and Wibbels, 2002)(7).
Corruption: To the question of whether corruption is more prevalent under federal or unitary constitutions, there is one standard answer: constituent governments are closer to the people, play infinitely repeated games with local constituents, and hence are subject to local capture (see, e.g., Tanzi, 2000)(3). Therefore, corruption levels will be higher under federal than under unitary constitutions.
Vs: The standard argument against the local capture hypothesis is that the behavior of constituent governments is more transparent in federations and politicians are, hence, more accountable for their actions. This would imply that corruption is lower under federal constitutions.
Additionally, corruption can signal an inadequacy in the relevant rule system; under dysfunctional rules, even welfare- enhancing activities will often require corrupt behavior. This assumption leads to the argument that since the constituent units of federal states are closer to the people, it is likely that their rules will be more adequate than those in unitary states.
Parisi I 212
Government spending: For a long time, the evidence concerning the effects of federalism on overall government spending was mixed. Over the last several years, though, this appears to have changed. Rodden (2003)(8) shows for a cross-country study covering the period 1980 to 1993 that in countries in which local and state governments have the competence to set the tax base, total government expenditure is lower. >Direct Democracy/Constitutional economics
, >Governmental structures/Constitutional economics.

* The relationship between the central government and the lower units in unitary states might be more aptly described drawing on principal-agent theory with its familiar monitoring problems. For such a view, see Seabright (1996)(4).

** Rodden (2002(5), p. 6 72) points out that the creditworthiness of the federal
level might be jeopardized if it does not bail out the constituent governments.

1. Hayek, F. (1939). "Economic Conditions of Inter-State Federalism." New Commonwealth Quarterly 2: 131-149.
2. Tiebout, Ch. (1956). "A Pure Theory of Local Expenditures." Journal of Political Economy 64: 416-424.
3. Tanzi, V. (2000). "Some politically incorrect Remarks on Decentralization and Public Finance," in J.-J. Dethier, ed., Governance, Decentralization and Reform in China, India and Russia, 47-63. Boston, MA: Kluwer.
4. Seabright, Paul (1996). "Accountability and Decentralization in Government: An Incomplete Contracts Model." European Economic Review 40:61-89.
5. Rodden, J. (2002). "The Dilemma of Fiscal Federalism: Grants and Fiscal Performance around the World." American Journal of Political Science 46(3): 670-687.
6. Wildasin, D. (1997). "Externalities and Bailouts: Hard and Soft Budget Constraints in Intergovernmental Fiscal Relations." Nashville, TN: Mimeo.
7. Rodden, J. and E. Wibbels (2002). "Beyond the Fiction of Federalism - Macroeconomic Management in Multitiered Systems." World Politics 54: 494-531.
8. Rodden, J. (2003). "Reviving Leviathan: Fiscal Federalism and the Growth of Government." International Organization 57: 695-729.

Voigt, Stefan. “Constitutional Economics and the Law”. In: Parisi, Francesco (ed) (2017). The Oxford Handbook of Law and Economics. Vol 1: Methodology and Concepts. NY: Oxford University

Explanation of symbols: Roman numerals indicate the source, arabic numerals indicate the page number. The corresponding books are indicated on the right hand side. ((s)…): Comment by the sender of the contribution. Translations: Dictionary of Arguments
The note [Concept/Author], [Author1]Vs[Author2] or [Author]Vs[term] resp. "problem:"/"solution:", "old:"/"new:" and "thesis:" is an addition from the Dictionary of Arguments. If a German edition is specified, the page numbers refer to this edition.
Constitutional Economics
Parisi I
Francesco Parisi (Ed)
The Oxford Handbook of Law and Economics: Volume 1: Methodology and Concepts New York 2017

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